Mary Linden is seeking financing for a $900,000 investment project. An insurance
ID: 2482389 • Letter: M
Question
Mary Linden is seeking financing for a $900,000 investment project. An insurance company has offered to purchase the warehouse for $1,240,000 and rent it back to Mary under a 6 year-lease. Mary would remain liable for property taxes of $34,200 per year and maintenance of $14,300 per year plus an annual rent of $277,409.73 wiith the first payment made today then each January 1st on the 6 year lease. This rental amount insures the insurance company a 12% return on their investment of $1,240,000. This arrangement is called a sales/leaseback.
Additional Information:
The investment of the $900,000 will produce a pretax return of 18% of unearned income for nine years. Mary is currently in the 39.6% marginal tax bracket and files a single tax return.
Required:
Analyze after net tax return using future time value presentation
Explanation / Answer
First we need to do the Cost and Benefit Analysis and decide whether going for Sale and Lease back option and investing in Project is feasable or not.
We need to first Present Value of all Expenses and Revenue and Net Cash Flows.
If Mary Opts for Insurance company proposal,
Particulars Amount ( $) Period Present Value ($).
A. Revenue
Sale Proceeds of Wharehouse 1,240,000 Today 1,240,000
Return on Investment in Project 97,848 9 Years 521,366 ( Approx)
Total Present value of Cash Inflows- Revenue 1,761,366 (A)
B.Expenditure
Property Taxes 34200 6 years 140,610
Maintenance 14,300 6 years 58,793
Annual rent 277,409.73 5 years 1,277,410
Total PV of Cash out lows- Expenses 1,476,812 (B)
Total PV of Net Cash Flows on opting for Sale and Leaseback
A. PV of Revenue 1,761,366
B. PV of Expense 1,476,812
Net Cash Flows ( A-B) 284,553
Conclusion: Since the PV of net cash flows on opting for Sale and lease back of wherehouse and investing in projects results into positive $ 284,553/- cash flows. it is advised for mary to go ahead with the insurance company proposal.
Notes.
1.( Annual Rent is to be discounted only for 5 years and add the first instalment amount as it is paid today itself.)
2. PV of Annuty cash out flows for Expenses ( i.e, Property taxes, Annual rent & maintenace ) are calculated in the same way as Revenue is calculated ( Same formula) . Just check you will get the same amounts which i put here.